As an entrepreneur, you’re likely a visionary leader. You have the hustle and grit to make things happen and bring your business ideas to life. While successful businesses rely on these entrepreneurial qualities, where they can come unglued is with their finances and accounting. Sound familiar?
Understanding accounting principles can be the difference between steering your business into choppy waters or smooth sailing to scale and growth. We explain the core concepts of Accounting 101 that entrepreneurs should be across.
Understand unit economics
Do you know what the lifetime value of a customer is for your business? Without that understanding of unit economics, you’re flying blind. Without it, you can’t be sure that your business model is a successful one.
To calculate your unit economics, you need to know your customer acquisition cost and both the revenue value and margin of a customer over their lifetime. Divide customer lifetime value by your customer acquisition cost to get your unit economics. This can be quite the eye opener.
In the short to medium term, you may have negative unit economics. This isn’t necessarily a bad thing, as long as you have a plan in place to improve this. For example, your strategy may be to increase market share followed by a gradual increase of your pricing or margins.
In today’s funding market, clear and profitable – ideally – unit economics is critical for gaining investment and long term profitability.
Build operating leverage
What proportion of your costs are fixed vs variable? Your operating leverage is how much you can increase your operating income through revenue increases.
If you can build a business model where costs fix at a certain point, your business is more likely to be highly profitable. In turn, that profitability is extremely attractive to investors.
If you have small margins, it’s likely that you have high variable costs. This makes it more challenging to get a solid return on investment.
Operating leverage is important because it helps to determine your break even point. It’s a measure of how well you’re squeezing your assets to generate profit.
Forecast your cash runway
Do you have a clear picture of your cash flow and when you may need to top up your cash reserves? Not all businesses are profitable from the start. In fact, most take some time to reach the point of profitability.
If you rely on external financing for cash flow, you need to have a clear picture of when you’ll need additional cash injected into the business. There is one surefire way to blow up a shareholder relationship, and that’s to ask them for money at the eleventh hour.
You should communicate regularly with your investors around cash flow so there is complete clarity around their support for additional funding; likewise, if the business needs to change course such as a cut to profitability or a complete wind down.
Manage costs and budgets carefully
How closely do you monitor your business expenses? By their very nature, startups have a tendency to burn cash. At a time when funding is much harder to come by, every dollar is precious.
As an entrepreneur, you need to understand every line item in your P&L (profit and loss). Efficiency is key. You need to ensure that every dollar you’re spending is working hard to propel your business towards success. When you know what you’re spending, it’s easier to spot wastage and identify opportunities to cut costs.
It may seem like overkill, but when money is tight – as it so often is – signing off on spending can help to ensure you stay on budget.
Your startup accounting partner
Does this seem daunting? Like, just one more thing you need to be worried about in the already busy startup life? The reality is, if you aren’t across these accounting principles, it won’t bode well for your business.
But you don’t need to go it alone. The Vital Addition Outsourced Finance Team takes your accounting off your plate and places it in the hands of a trusted partner. We understand the challenges of entrepreneurship because we’re entrepreneurs ourselves.
Contact us to discuss your startup business and how we can partner with you to understand your business finances, create efficiencies and drive profitability.